Standard Accounting or Cash Accounting: The Difference

General Explanation

Cash accounting is the most straightforward system to use and understand because it maps exactly onto the monies that you receive and pay. This means that your profit and/or loss can be calculated from only your bank (and cash) transactions. With regard to taxes, it means that taxes are calculated only on the money that you have collected and the money that you have paid out.

Standard accounting is more complicated because it calculates your profit and/or loss not from the moneys you have received and paid, but from the value of the invoices you have issued, whether you have received payment or not. You may also have made purchases that you can claim as goods as soon as you receive the supplier’s invoice, whether you have actually paid for the goods or not.

Note that if you do not give credit to your customers and do not buy goods and services on credit from your suppliers, there is no technical difference between Cash Accounting and Standard Accounting. This is because all accounting will be based on monetary transactions that happen at the time of sale and/or purchase, exactly as represented in your bank statements.

Before going further it is important to note that HMRC has two distinct ‘Cash Accounting’ regimes with different rules for each. These are:-

• Cash Accounting for Annual Accounts
• Cash Accounting for VAT

1. Cash Accounting for Annual Accounts

Obviously cash accounting would be much easier for everyone to use on a day to day basis, but there are extreme disadvantages if you use it:-

a) From your own point of view, cash accounting does not help you to keep track of your trading debtors and creditors, i.e. Profit and loss calculated only from monetary transactions does not take into account your actual trading position, which could be much better if you have a substantial value of unpaid invoices, or much worse if you have a substantial value of unpaid supplies.

b) If you use ‘cash accounting’ officially with regard to your self assessment or partnership tax returns, HMRC will prevent you from claiming certain types of capital equipment allowances. Also, you will not be able to carry forward profits or losses, which can be used to spread the ups and downs of your tax payments over a period of four or five years.

c) You cannot use cash accounting if you are a limited company, a community interest company or a limited liability partnership. Note also that self employed sole traders and partnerships cannot use cash accounting if their turnover (total sales) is more than £300k per year.

There are simply far too many disadvantages in using cash accounting for any business to use it for their annual accounts.

2. Cash Accounting for VAT

For VAT, cash accounting has only minor cash flow disadvantages for a minority of businesses. For businesses with annual sales of less than £1.65m cash accounting for VAT is the norm and there are distinct advantages in using it for VAT:-

a) There is no requirement to inform HMRC that you are using cash accounting for VAT. If your total sales are below £1.65m, they will assume that you are using it.

b) Cash accounting makes your VAT returns much easier because they can be calculated solely on your bank (and cash) transactions.

c) If your customers generally owe to you, more than you owe to your suppliers, then cash accounting for VAT will help your cashflow, because you do not have to pay VAT on money that you have not yet received.

Note that businesses with annual sales in excess of £1.65 cannot use cash accounting for VAT. Based on the point at c) above, this obviously benefits the cashflow of HM Government rather than your business. For some businesses with annual sales of less than £1.65, there may be disadvantages in using cash accounting for VAT:-

d) If your business is in retail, it may be that all of your sales are immediate and you have no customers who owe you money. If you are buying stock from suppliers on credit, then you will not be able to claim the VAT on your supplies until you actually pay the bills. i.e. your cashflow will be adversely affected. If the amounts are substantial, you should use ‘standard accounting’ for VAT.

So, in general: Cash accounting for annual accounts; to be avoided always. Cash accounting for VAT; use it if your annual sales are below £1.65m, unless you are in retail and taking credit from your suppliers.